Elite company is planning to add a new product to its line. To manufacturer this

Question

Elite company is planning to add a new product to its line. To manufacturer this product, the company needs to buy a new machine at a $300,000 cost with an expected 4 year life and a $20,000 salvage value. All sales are for cash, and all cost are out of pocket except for the depreciation on the new machine. Additional information includes the following: -cost of new machine $300,000 -life of new machine in years 4 -salvage value if new machine $20,000 -expected annual sales of new product $1,150,000 Expected annual cost of new product : -direct materials $300,000 -direct labor $420,000 -overhead excluding SL depreciation on new machine $210,000 -selling and administrative expenses $100,000 -income taxes 30% -discount rate for net present value of investment 7% 1. Compute the straight line depreciation for each year of this new machine

Explanation / Answer

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1. Compute straight- line depreciation for each year of this new machine's life. ( Round depreciation amounts to the nearest dollar.) Solution: Computation of the Depreciation for each Year under Straight line method Cost $300,000 Salvage value $20,000 Depreciable basis $280,000 Useful life (in years) 4 Annual straight-line depreciation $70,000 Hence the Annual straight-line depreciation for each year is $70,000 2. Determine expected net income and net cash flow for each year of this machine's life. ( Round answers to the nearest dollar.) Solution: Computation of the Expected Net Income and Net Cash flow Particulars Amount Amount Expected annual sales of new product $1,150,000 Expected annual costs of new product Direct materials $300,000 Direct labor $420,000 Overhead excluding depreciation $210,000 Depreciation $70,000 Selling and administrative expenses $100,000 Total expected annual costs of new product $1,100,000 Expected annual pre-tax net income $50,000 Income taxes $15,000 Expected annual net income $35,000 Expected annual net income $35,000 Depreciation $70,000 Expected annual net cash flow $105,000 Hence the Expected annual net income is $35,000 Expected annual net cash flow $ 105,000 3. Compute this machine's payback period, assuming that cash flows occur evenly throughout each year. ( Round the payback period to two decimals.) Solution: Computation of the Machine Payback period Initial investment $            300,000 Expected annual net cash flow (Years 1-3) $            105,000 Payback period in years 2.86 Years Hence the Payback period in years is 2.86 Years 4. Compute this machine's accounting rate of return, assuming that income is earned evenly throughout each year. ( Round the percentage return to two decimals.) Solution: Computation of the Accounting Rate of Return Average annual net income $35,000 Cost $300,000 Salvage value $20,000 Total investment $320,000 Average investment $160,000 Accounting rate of return 21.88% Hence the Accounting Rate of Return is 21.88% 5. Compute the net present value for this machine using a discount rate of 7% and assuming that cash flows occur at each year- end. ( Hint: Salvage value is a cash inflow at the end of the asset's life. Round the net present value to the nearest dollar.) Solution: Computation of the Net Present Value Annual operating net cash flows $105,000 Present value of annual operating net cash flows $355,657 Salvage value in Year 4 $20,000 Present value of salvage value in Year 4 $15,258 Initial investment $(300,000) Net present value $70,915 Hence the Net Present Value Is $70,915

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